Tag: Transaction costs

Physical tasks can normally be broken up in a reductionist way. Bigger tasks can be divided by assigning people to different smaller parts of the whole. For intellectual tasks, it is much harder to find parts that make for an efficient workflow. Intellectual tasks are by default complex and linked. Knowledge work is a social construct.

The machine metaphor led to the belief that if we can only arrange the parts in the right way, we optimize efficiency. The demands of work are different now: how efficient an organization is reflects the number of links people have and the quality of the links they have to the contexts of value, the things that matter.

How many handshakes separate them from one another and from the things that matter most? We are beginning to see the world in terms of relations.

We have examples of new social architectures that redefine some basic beliefs about work and cooperation between people.

At the moment the wiki is the best departure from the division of labor and workflows. Wikis let people work digitally together in the very same way they would work face-to-face. In a physical meeting, there are always more or less the wrong people present and the transaction costs are very high. Unlike email, which pushes copies of the same information to people to work on or edit separately, a wiki pulls non co-located people together to work cooperatively, and with very low transaction costs. Email and physical meetings are methods which exclude. They always leave people out. A wiki, depending on the topic, the context and the people taking part, is always inviting and including. The goal is to enable groups to form around shared contexts without preset organizational walls, or rules of engagement.

In 1995 Ward Cunningham described his invention as the simplest online database that could possibly work. An important principle of the wiki is the conscious emphasis on using as little structure as possible to get the job done. A wiki does not force a hierarchy on people. In this case, less structure and less hierarchy mean lower transaction costs. A wiki always starts out flat, with all the pages on the same level. This allows people to dynamically create the organization and, yes, also the hierarchy that makes most sense in the situation at hand.

People work together to reach a balance of different viewpoints through interaction as they iterate the content of work. The wiki way of working is essentially a digital and more advanced version of a meeting or a workshop. It enables multiple people to inhabit the same space, see the same thing and participate freely. Some might just listen, some make comments or small edits, while others might make more significant contributions and draw more significant conclusions.

New work is about responsive, free and voluntary participation by people who contribute as little, or as much as they like, and who are motivated by something much more elusive than only money. Society has moved away from the era of boxes to the time of networks and linked, social individualism. Being connected to people, also from elsewhere, is a cultural necessity and links, not boxes, are the new texture of value creation.

Lately I have had a series of conversations with a group of leaders of global high-tech companies. It became very clear during my conversations that their vocabulary reflected a fresh, new way of thinking about work. The executives emphasized that the key to success in the new digital economy is likely to be a new position for knowledge professionals and a wide social acceptance of more sustainable values.

What could this new position look like?

Once acquired, knowledge and skills that are specialized to a given enterprise are assets that are at risk in the very same way that financial assets are at risk. If one can’t continue for some reason, the value of context-specific knowledge and competencies may be much lower somewhere else. Human capital then follows very much the same logic as financial capital and should be treated accordingly.

There is, however, one major difference. Human capital is by definition always social and contextual. The capabilities of the members of a team are worth more together than when applied alone. With context-specific human capital, the productivity of a particular individual depends not just on being part of a community, but on being part of a particular group engaged in a particular task. The contextual and social aspects of business matter much more than we have understood.

The ten principles of digital work, the new standards, that the leaders acknowledged:

informed free choice, rather than compliance, is the basis for decisions

active participation, rather than passively accepting instructions, is the basis of growth and development

work activities are carried out within a framework of personal responsibility and goals for self-direction rather than direction from outside

activities are carried out in a transparent way with the goal of distributing the cognitive load of work rather than work being based on reductionist principles and social isolation

one is responsible for one’s own actions rather than being responsible to someone else

a worker is engaging in complex, responsive activities with others in contrast with engaging in closed repetitions of the same activity

the network, rather than offices or organizational hierarchies, is the main architecture of work

productivity is a result of creative learning rather than doing more of the same. Increasing the quality and speed of learning matter more than increasing the quantitative output of work

knowledge work can be understood as investments of human capital following the same logic we have used to understand financial investments. Workers should share the responsibilities and possible upsides that used to belong only to the investors of financial capital.

knowledge work is about interdependent people in interaction. Intelligence, competence and learning are not any more about the attributes and qualities of individuals but about the attributes and quality of interaction

All of us have at some point in our lives experienced performance appraisals where we as individuals were evaluated. This approach to judgment was the same in school and at work: individuals separated from other individuals.

As a result of recent developments in psychology and sociology, we are now leaving behind the preoccupation with the autonomous individual and beginning to appreciate the importance of relational processes and interdependence. The way we perceive organizations is changing accordingly. Rather than an organization being though of as an imposed structure of separate, autonomous functions, today’s organization arises from the interactions of individuals who need to come together. An organization is a continuous process of organizing.

This shift in the way we see organizations changes the way we perceive competitive advantages. The new competitive edge comes from openness and interactive capacity: the ability to participate and connect, as and when needed.

Similarly produced products with the same product features are used by different customers in different ways. Just because a product is a commodity doesn’t mean that customers can’t be diverse in their needs and the way they use the product.

Companies used to have no mechanisms for connecting with the end users in order to understand and influence this. Social media and mobile technologies are now changing this.

Organizations are creative, responsive processes of communication. All creative, responsive processes have the capacity to constantly self-organize and re-organize. Change is not a problem or anomaly. Solutions are always temporary and contextual.

In this view, it is information that is the energy of organizing. Or, as Gregory Bateson wrote, “information is a difference, which makes a difference”. When we see information as a power plant that has the ability to organize and change the organization, we realize the power of openness. When information is transparent to everybody, people can organize effectively around changes and differences, around customers, products and new technologies.

When information is transparent, different people see different things and new interdependencies are created, thus changing the organization. The easier the access that people have to one another and to (different) information is, the more possibilities there are. What we have still not understood is that people need to have access to information streams that no one could predict they would want to know about. Even they themselves did not know they needed it – before they needed it. Thus information architectures can never be fully planned in advance.

No one person or function can meet today’s challenges alone. We need a community of people who willingly participate and provide their insights to address increasingly interdependent issues. Collaboration is necessary because one person no longer has the answer. Answers reside in the interaction, between all of us.

Therefore the challenges of today are engagement and reducing the transaction costs of participation. Widening the circle of involvement means expanding who gets to participate, comment and contribute. It is about inviting and including relevant, new and different voices.

The unfortunate misunderstanding is that engaging people requires managers to let go. As managers contemplate widening the circle of involvement they sometimes believe that it means to have less ability to provide input based on their knowledge and experience. Paradoxically, engaging more people requires more from managers than the current management paradigm.

Instead of being responsible for identifying both the problem and the solution, they are now responsible for identifying the problem and identifying the other people whose voices need to be heard. Who else needs to be here? How do I invite people who do not report to me? How do I invite customers and other people from outside our organization?

Success today is increasingly the result of skilful management of participation: who is included and who is not. Who is needlessly excluded from the information streams and the subsequent interaction?

A common misunderstanding is that productivity will suffer if larger numbers of people are involved. The new social platforms and interaction technologies have dramatically reduced the cost of communication and participation. Temporary, flash communities can be formed to solve a problem or to tackle an opportunity more easily, more cheaply and faster than ever before – if there is openness and people are invited and if people want to engage. It is about distributing the intellectual tasks at hand and integrating the contributions of many resulting in creative learning.

Creative learning is the new productivity. In creative, interactive work, productivity cannot be measured in quantitative terms or as a difference between input and output, but as the speed and quality of learning.

The management task is not to understand people better, but to understand better what happens, and can happen between people. Our world is co-created in relations.

The nature of the relationship between customers and firms has changed dramatically. For over a hundred years, companies have assumed that consumers are an undifferentiated mass. Lately, we have moved through different degrees of market segmentation. Today, we have reached a point where the latest interaction technologies are creating an entirely new dynamic between the firm and the people we used to call consumers. Tomorrow firms will compete in making unique customer experiences possible.

The traditional approach was that the firm created value and then exchanged it with its customers. This firm-centric view of value creation is now being replaced by customers’ contextual experiences and co-created value. Value is created in interaction, but outside the corporate firewall. Even if a company is dealing with a very, very large number of customers, the firm must focus on one customer at a time.

We are in a world in which value is determined by co-created experiences – all a bit alike but all a bit different.

During the still (mentally) prevailing industrial era, most firms were vertically integrated. It was only around twenty-something years ago that firms started to source components from outside, from suppliers on a large scale. Today it is natural to rely on global supply chains. This is because the business goal is to access the most competent, knowledgeable sources and paradoxically, at the same time the lowest-cost producers. Access to resources and resource allocation is today by default multi-vendor, crowdsourced and global.

The changing relationships with customers and vendors are the main drivers behind the new ecosystems for communication and participation.

These trends also explain the situation we are in at the moment. The network is the architecture of work. People need to communicate and participate in order to invite contributions and to co-create unique experiences. It is about the relational view. It is not necessary to own the contributing parties. Capacity to connect and cooperate is what is needed. Cooperation is the new competition.

The world we live in today is in many ways the polar opposite of what we have been used to. The management challenge in the era of social media is to invite and combine the contributions of many in order to participate with one (at a time).

Technology does not determine social and organizational change, but it does create new opportunity spaces for social innovations like new employment forms. Partial employment for young unemployed people is becoming much easier than before, and truly global task-based work is becoming possible, perhaps for the first time in history.

The opportunity today is in new relational forms that don’t mimic the governance models of industrial, hierarchical firms. We are already witnessing the rise of very large-scale efforts that create tremendous value in a very new way. Coordinated value in the cases of helping Haiti or building Wikipedia type of platforms is the result of uncoordinated actions by a large number of individuals. People with different goals, different values and different motivations take part and co-create together.

The characteristics of the network economy are different from what we are used to: the industrial production of physical goods was financial capital-intensive, leading to centralized management and manufacturing facilities where you needed to be at during predetermined hours. The industrial era also created the shareholder capitalism we now experience. Having a great idea, or simply wanting to do something, was not enough to get one going. You needed a lot of money. In the network economy, individuals, interacting with each other by utilizing free or low cost social platforms and relatively cheap mobile, smart devices, can now create information products.

The production of information goods requires more human capital than financial capital. It is more about connecting with brains than connecting with money. And the good news is that you are not limited to the local supply. Work on information products does not need to be co-located. The architecture of work does not resemble a factory any more.

This is why decentralized action plays a much more important role today than ever before. The architecture of work is the network and the basic unit of work is not a process or a job role but a task.

Our management and organizational thinking is derived from the era of tangible goods production and high-cost/low-quality communications. These mindsets are not helpful in a world of widely distributed ownership of means of production/smart devices and ubiquitous connectivity.

“A corporation/employer exists to make money and the employee goes to work for the employer to make money.” Almost all economic theories have made the same assumption: the employer – employee relationship is necessary to make work possible.

We have taken that relationship as given. The other taken for granted assumption is that it is the independent employer/manager who exercises freedom of choice in choosing the goals and designing the rules that the members of the organization are to follow. The employees of the organization are not seen autonomous, with a choice of their own, but are seen as rule-following, dependent entities. People are resources.

Dependence is the opposite of taking responsibility. It is getting the daily tasks that are given to you done, or at least out of the way. We are as used to the employer choosing the work objectives as we are used to the teacher choosing the learning objectives. The manager directs the way in which the employee engages with work, and manages the timing and duration of the work. This image of work is easy to grasp because it has been taught at school where the model is the same.

In contrast to the above, digital work has brought about circumstances in which the employee in effect chooses the purpose of work, voluntarily selects the tasks, determines the modes and timing of engagement, and designs the outcomes. The worker here might be said to be largely independent of some other person’s management, but is in effect interdependent. Interdependence here means that the worker is free to choose what tasks to take up, and when to take them up, but is not independent in the sense that she would not need to make the choice.

The interdependent, task-based worker negotiates her work based on her own purposes, not the goals of somebody else, and chooses her fellow workers based on her network, not a given organization. The aim is to do meaningful things with meaningful people utilizing networks and voluntary participation.

It is not the corporation that is in the center, but the intentions and choices of individuals. This view of work focuses attention on the way ordinary, everyday work-tasks enrich life and perpetually create the future through continuous learning.

The architecture of work is not the structure of a corporation, but the structure of the IT-network. The organization is not a given hierarchy, but an ongoing process of organizing. The basis of work is not financial self-interest, but people’s different and yet, complementary expectations of the future, conditioned by their accounts of the past and developed skills.

The factory logic of mass production forced people to come to where the work is. The crowdsourcing logic of mass communication makes it possible to distribute work to where the people are, no matter where on the globe they may be.

Knowledge work is not about jobs or job roles but about tasks. Most importantly knowledge work can, if we want, be human-centric. Through mobile smart devices and ubiquitous connectivity, we can create new opportunities and a better future for millions of unemployed people.

Corporations are the dominant mechanism by which economic activity is organized in developed countries. Whether there are opportunities for leaner and more agile approaches to value creation in the corporate context, is hence a key question for the prosperity and well-being in the society.

The big move we are in the midst of is towards an economy that is more centered on information products than physical products. Examples of this are financial services, professional services in general and software.

The second transformative change is global access to relatively cheap and relatively high quality communication networks.

New communication technologies have always had a strong impact on the production of information. But this time the societal changes are huge. The Internet is the first communication environment that decentralizes the financial capital requirements of producing information. Much of the capital is not only distributed but also largely owned by the end users. Network servers are not very different from the computers we have at home. This is a complete departure from the model of TV broadcast stations and televisions.

The characteristics of the new economy are different from what we are used to: the production of physical goods was (financial) capital-intensive, leading to centralized management structures and the shareholder capitalism we now experience. The production of information goods always requires more human capital than financial capital. It is much more about finding brains than finding money. But the good news is that you are not limited to the local supply. Work on information products does not need to be co-located. If the task at hand is inviting and compelling, human capital investments can come from any part of the network.

This is why decentralized action plays a much more important role today than ever before. The architecture of work is the network and the basic unit of work is not a process or a job role but a task.

Our management and organizational approaches are derived from the era of tangible goods production and high-cost/low-quality communications. These mindsets are not helpful in a world of widely distributed value creation and ubiquitous connectivity.

The opportunity is in new relational forms that don’t mimic the governance models of industrial, hierarchical firms. We are already witnessing the rise of very large-scale collaborative efforts that create tremendous value. Coordinated value in these cases is the result of uncoordinated actions by a large number of individuals with different goals, different values and different motivations to take part.

The financial capital constraints on action meant that having a great idea, or simply wanting to do something, was not enough to get one going and trying it out. In the networked economy, information products can now be created and co-created in a human-centric way, by interdependent individuals, interacting with each other by utilizing free or low cost social media.

Technology does not determine social and organizational change, but it does create new opportunity spaces for new social practices. Some things are becoming much easier than before and some things are becoming possible, perhaps for the first time.

Pitching in the world that is built on the centrality of information and radical decentralization of intelligence may be more about justifying human capital investments than justifying financial investments. Perhaps start-ups in the future won’t even seek to create jobs at all because of their industrial-era nature, but may see themselves as platforms for all kinds of contributions from all over the network they are an active part of.

The modern business enterprise is easily defined. It has two particular characteristics: it contains many separate operating units and a hierarchy of executives. As a social innovation the modern enterprise was born when the volume of economic activities reached a level that made administrative coordination more efficient and more lucrative than market coordination.

Before the rise of the modern firm, the activities of small, often personally owned enterprises were enabled and constrained by market and price mechanisms.

The important innovation of the modern firm was to “internalize” activities by bringing many discrete components under one roof and under a system of coordination. The modern multi-unit business corporation replaced the small, single-unit, enterprise because administrative coordination permitted greater productivity and lower (transaction)costs per task than was possible before.

The big idea behind industrial management was to purchase or set up units that were fit enough to operate as independent entities, but instead integrate them into one system. Bringing these activities together gave the corporation many advantages: by standardizing interaction between units, the cost of transactions were lowered and the cost of information on markets and sources of supply were dramatically reduced.

The principle of internalization permitted the flows of goods, services and information to be planned from one unit to another. Budgeting of flows allowed more efficient use of facilities and personnel than was the norm earlier. The advantages of internalizing many business units within a single enterprise could not be realized without management.

Managers essentially carried out the functions formerly handled by price and market mechanisms. Managers were now the enablers.

The practices and procedures that were invented at the dawn of industrialism have become standard operating methods and are still taught in business schools today. The existence of a managerial hierarchy as means for coordination is not questioned. It is the defining characteristic of the modern business enterprise.

Two aspects of work have changed dramatically. First, all financially successful offerings involve customization, or aggregation by the end-user. This means that companies must thrive in situations where very little information or communication can be made routine. Second, all successful firms are actively involved in emergent, responsive interaction with people “outside”: customers and network partners. These firms understand that value is not created inside the organization but in the larger ecosystem they are one part of.

We all have mindsets of the world that serve as maps that guide what we see and how we understand the world around us. The maps can be helpful but also outdated and incorrect. Management practices of the industrial, passive-mass-consumer era were based on standardization, management coordination and repetition. These approaches and principles are not just less useful, but critically wrong today.

Both of the change drivers: customization and interactive value creation, demand that firms value people more than they value budgets, processes, organizational units and hierarchies. Firms must attract and link contributions from skilled individuals – no matter where those people are and where those contributions come from. The products the firm sells to its clients are not offerings of the firm per se, but offerings created by specific individuals in specific situations of “local” interaction. This is why business-to-business (B2B) value systems are not different from business-to-customer (B2C) value systems. It is about people in interaction in both cases. Work is always interaction between interdependent individuals.

Interaction can only partially be planned in advance. People need to participate based on transparent information and high quality communication systems enabling responsiveness. Some work is also in the future located “inside” the firm, but the really important part of interaction takes place “outside“. A larger and larger number of the contributing individuals are necessarily customers and network partners who are outside the company Intranet as we know it know. The explanation for this is that it is now more expensive to internalize than to network. The fundamental principles of organizing are changing because of the Internet and the low cost and high quality of communication. This is why there are no, and never will be, successful social media implementations inside firewalls.

Work today is network-enabled, situational collaboration based on interdependency that typically links operational units and spans over traditional value systems. The approach that managers do the coordination for the workers is just too slow and too costly in the low transaction cost environments we live in today.

The enablers have turned into a constraint.

The systems of value creation need to be architectures that make wide area participation possible. The goal is interoperability and low barriers to experimentation and networkedlearning.

The task today is to create a valid context in which people think about and experience social media / social business. The difficulty is that this context has to make sense in the world we are going to, and not the world we are coming from.

Physical tasks can normally be broken up in a reductionist way. Bigger tasks can be divided by assigning people to different smaller parts of the whole. For intellectual tasks, it is much harder to find parts that make for an efficient division of labour. Intellectual tasks are by default linked and complex. Reductionism does not work.

The machine metaphor led to the belief that if we only can arrange the parts in the right way, we optimize efficiency. When the image of work was the assembly line, work could be fragmented and individual performance goals could be set for each worker. The world was all about little boxes separated from one another.

The demands of work are different now: how efficient an organization is reflects the links people have with one another and the links they have to the contexts of value. How many handshakes separates them from one another and from the things that matter? We are beginning to see the world as relations.

When we talk about relations, we often take examples from nature: murmuration and bird flocks. The V shape of a bird flock does not result from one bird being selected as the leader, and the other birds lining up behind the leader. Instead, each bird’s behaviour is based on its position relative to nearby birds. Ornithologists say that the V shape is not planned or centrally determined; it emerges out of simple, and relatively few, rules of interaction. The bird flock demonstrates a striking feature of emergent phenomena. But the birds do not need to figure out the rules of flight that guide how they organize themselves. These rules are genetically hardwired. Nature provides this for the birds. Birds then are not “free like birds”.

When it comes to people it is a different story. Mother nature does not provide deterministic rules for collaboration. We are free to choose, or not to choose, our own ways of doing things together. Accordingly we are ourselves responsible for formulating the principles we use to organize our life. Social systems are thus fundamentally different from natural mechanisms.

We have examples of social architectures that redefine some basic beliefs about social systems.

The wiki is at the moment the best departure from division of labor and workflows. Wikis let people work digitally together the very same way they would work face-to-face. In a physical meeting, there are always more or less the wrong people present and the transaction costs are very high. Unlike email, which pushes copies of the same information to people to work or edit separately, a wiki pulls non co-located people together to work collaboratively, and with very low transaction costs. Email and physical meetings are excluding ways of doing things. They leave people out. A wiki (depending on the topic, the context) is always inviting and including. The goal is to enable groups to form around shared contexts without preset organizational walls, or rules of engagement.

Ward Cunningham described his invention in 1995 as the simplest online database that could possibly work. An important principle of the wiki is the conscious emphasis on using as little structure as possible to get the job done. A wiki does not force hierarchy on the people. In this case, less structure and less hierarchy mean less transaction costs. A wiki always starts out flat, with all the pages on the same level. This allows people to dynamically create the organization and hierarchy that makes most sense in the situation at hand to get the job done.

People work together to reach a balance of different viewpoints through interaction as they iterate the content of work. The wiki way of working is essentially the digital and more advanced version of a meeting or a workshop. It enables multiple people to inhabit the same space, see the same thing and participate freely. Some might just listen, some make comments or a small edits, while others might make more significant contributions and conclusions.

New work is about responsive, free and voluntary participation by people who contribute as little, or as much as they like, and who are motivated by something much more elusive than only money. The society has moved away from the era of boxes to the time of networks and linked individualism. Being connected to people – from elsewhere – is a cultural necessity and links, not boxes, are the new texture of value creation.

What is the purpose of an employer? Why do employees go to work? These basic questions have so far had very obvious answers. A corporation exists to make money and the employee goes to work for the employer to make money. Almost all economic theories make the same assumption: the employer – employee relationship is a simple business transaction that makes work possible.

Adam Smith assumed that this transaction is by definition mutually beneficial for both parties. Marxists, on the other hand, would say that the employer will always exploit the employee and that the relationship is thus inherently conflictual. Frederick W. Taylor, the father of scientific management, believed that the relationship is often characterized by uninformed employers mistreating and misusing employees. If employers are enlightened, they can increase productivity and share more profits with the employees. This is, at least partially, the philosophical reasoning behind management education.

Regardless of their differences, these three perspectives all take the employer – employee relationship as given. The other taken for granted assumption is that it is the independent employer/manager who exercises freedom of choice in choosing the goals and designing the rules that the members of the organization are to follow. The employees of the organization are not seen autonomous, with a choice of their own, but are seen as rule-following, dependent entities. People are resources.

Dependence is the opposite of taking responsibility. It is getting the daily tasks that are given to you done, or at least out of the way, with a minimum of effort and unpleasantness. If dependent people can get work out of the way by doing it, they will do it. If experience has taught them that this does not work very well, they will turn to other, even illicit means.

We are as used to the employer choosing the work objectives as we are used to the teacher choosing the learning objectives. The manager directs the way in which the employee engages with work, and manages the timing and duration of the work. This image of work is easy to grasp because it has been taught at school where the model is the same.

In contrast to the above, digital work has brought about circumstances in which the “employee” in effect chooses the purpose of work, voluntarily selects the tasks, determines the modes and timing of engagement, and designs the outcomes. The worker here might be said to be largely independent of some other person’s management, but is in effect interdependent. Interdependence here means that the worker is free to choose what tasks to take up, and when to take them up, but is not independent in the sense that she would not need to make the choice.

The interdependent, task-based worker negotiates her work based on her own purposes, not the goals of somebody else, and chooses her fellow workers based on her network, not a given organization. The aim is to do meaningful things with meaningful people utilizing networks and voluntary participation. It is not the corporation that is in the center, but the intentions, choices and actions of individuals. This view of work focuses attention on the way ordinary, everyday tasks and conversations enrich life and perpetually create the future we truly desire.

The architecture of work is not the structure of a corporation, but the structure of the IT network. The organization is not a given hierarchy, but an ongoing process of organizing. The basis of work is not financial self-interest, but people’s different ad yet, complementary expectations of the future, conditioned by their accounts of the past.

The factory logic of mass production forced people to come to where the work is. The crowdsourcing logic of mass communication makes it possible to distribute work to where the people are, no matter where on the globe they may be. Knowledge work is not about jobs or job roles but about tasks. Most importantly knowledge work can, if we want, be human-centric.

Vladimir Lenin (1870-1924) famously said that the economic system in Russia after the revolution would be run as one big factory. Many economists at the time said that this was impossible. Yet there were already big factories in the West then, and there still are, so why not? Is there a limit to the size of a factory that cannot be surpassed, or is it because the factory logic cannot be used outside a real factory?

The typical hierarchical, factory, form of an organization is meant to simplify communication, accountability and the coordination of tasks. In theory an employee needs only one connection, to the boss. This is far easier than communicating with all and trying to coordinate actions with everyone. And what about accountability? The worker is accountable only to her manager. That manager reports to her manager on the next level up, and the chain goes further, leading in the end to – Lenin.

During the centuries since the publication of “The Wealth of Nations” in 1776 by Adam Smith (1723-1790), the principal theme of most economists has been that government regulation or centralized planning were not necessary, or even welcome, in order to make an economic system function well. The coordination would be the result of pricing mechanisms in markets. Lenin and the communists were advised to move to a market economy. The parties in this system follow their own self-interest and are “governed”, when it comes to the actual choices they make, by the system of prices and information they possess. This is the polar opposite of centralized planning. Adam Smith was a proponent of extreme decentralization and something that did not really have a name at the time – democracy.

Ronald Coase (1910-2013) was one of the first economists who started to question mainstream thinking in economics. If a system of prices and competition could perform all the coordination that is necessary, why did we have centralized planning, not only in the now bygone communist countries, but also in well-functioning and successful firms? Why did we need management, whose function was to coordinate? Why didn’t we rely on markets?

Ronald Coase set out to bring these two different views together. It is almost impossible now to fathom that he found the answer as early as during the summer of 1932, at the age of 22. He realized that there were costs involved in using the pricing mechanism. The needs and offerings have to find one another. The prices have to be discovered. Negotiations need to be undertaken. Contracts have to be made. There may be disputes that later have to be settled. Adam Smith did not see this. These costs were not part of “the invisible hand” equation. Ronald Coase called these costs transaction costs.

The first revolutionary argument was that a firm would emerge, exist and continue to exist successfully if it performed its planning, coordination and management functions at a lower cost than would be incurred by means of market transactions, and also at a lower cost than would apply if the same things could be performed by another firm. This is where competition keeps firms internally efficient and where non-competition in the public sector creates complex, non-efficient governance models and units that are too big.

The second revolutionary argument was that a well-functioning economic system needs both markets and planning. This depends on the size of the organization and the level of the market side transaction costs. Increasing the size increases the internal transaction costs. Running a sizable organization is difficult and running an even bigger organization is even more difficult.

Managerial overheads increase as the organization grows. Management, communication and coordination are all transaction costs. Every sales call, every offer, every agreement and every meeting also consumes limited resources and increases transaction costs. As the corporation grows, all its energy finally goes into maintaining the corporation and does not benefit external stakeholders.

Whenever the transaction costs inside the organization reach the level of the transaction costs in the (outside) markets, markets outperform firms and outperform central planning/coordination in general. This was the main theoretical argument against Lenin. The same thing is clearly still evident today in companies like GM or organizations like large health care units. Communist countries learned their lesson, but we still haven’t.

The existence of high transaction costs outside firms led to the emergence of the firm as we know it, and management as we know it. A large part of corporate economic activity is designed to accomplish what high market transaction costs prevented earlier.

If the (transaction) costs of exchanging value in the society at large go down drastically as is happening today, the form and logic of economic and organizational entities necessarily need to change! The firm, as we have known it, becomes the more expensive alternative. Accordingly, a very different kind of management is needed when coordination can be performed without intermediaries with the help of new technologies.

Today, we stand on the threshold of an economy where the familiar economic entities are becoming increasingly irrelevant. The Internet, and new Internet based firms, rather than the traditional organizations, are becoming the most efficient means to create and exchange value.

For most of the developed world, corporate hierarchies, as much as markets, make up the dominant economic pattern. The Internet is nothing less than an extinction-level event for the traditional firm as we have known it for the past 100 years. The Internet makes it possible to create totally new forms of economic entities.

The Internet changes our views of markets and hierarchies in ways that Adam Smith or Vladimir Lenin could never have imagined. But Ronald Coase did much to explain the theory behind Uber, Airbnb and other new market makers as early as 1932.